Climate physical risk on stock prices: evidence from S&P 500 stocks

We proposed a multivariate hidden Markov model (HMM) involving three climate-related variables: temperature anomalies, precipitation anomalies, and Google Trends on climate change topics. The proposed model detects the normal and abnormal climate conditions by capturing the contemporaneously regime-switching dynamics of the three climate-related variables. After the abnormal climate periods were identified by the proposed HMM, an event study methodology was applied to examine the impacts of the climate transition from normal to abnormal on the stock prices of the S&P 500 firms. We regarded the normal and abnormal climate transition as a physical climate risk. We collected the Bloomberg Environmental and Social (ES) scores for the S&P 500 companies. The S&P 500 firms were sorted into 11 sectors. The average ES scores were calculated for the 11 sectors. Our main findings show that sectors with poor environmental performance immediately respond negatively to climate risk. The sectors with good environmental performance behaves opposite to the sectors with poor environmental performance, which react to the climate risk positively.